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Alistair Barr, REUTERS

Don Kingsborough wants PayPal displayed alongside Visa, MasterCard and American Express in retail stores. To get there, he will compete aggressively on price.

As the executive leading PayPal’s push into physical stores, he hopes to tap long-simmering tensions over billions of dollars in fees the payment giants charge merchants each year.

Kingsborough said PayPal plans to subsidize its new service, implying merchants may pay less than they currently do for transactions done through established debit and credit payment processors.

To sweeten the deal and get the world’s top retailers on board, PayPal also plans to share more data on purchases and shopping activity.

EBay Inc, which owns PayPal, has set a public goal of 20 major retailers testing the point-of-sale, or POS, service by the end of 2012. Home Depot, the largest home improvement retailer, is running a test already and Office Depot is planning one.

Kingsborough, head of retail and prepaid products at PayPal, was even more confident in a recent interview with Reuters.

“We are going to do it with the greatest brands in the world — Home Depot and every other top-100 retailer,” Kingsborough said. “There isn’t a major brand who we haven’t talked to,” he added, while declining to identify other retailers.

There is a lot riding on this. PayPal is already a payment leader online, but e-commerce still accounts for less than 10% of U.S. retail sales. Going offline increases its addressable market by a factor of at least 10, according to Dana Stalder, a former eBay and PayPal executive who is now general partner at venture capital firm Matrix Partners.

“If PayPal can break into this it will be an enormous company,” Stalder said. He does not own eBay shares.

If PayPal can grab a 2% share of checkout at physical stores that would create a $70 billion business, according to eBay Chief Executive John Donahoe.

“2012 is trial and learn. 2013 and beyond is when we really scale it in the U.S. and globally and across categories,” Donahoe told Reuters in a recent interview. “That’s the goal I’m holding Don to in 2012 — do we have a scalable product?”

BLACKHAWK ROLODEX

Kingsborough, a 64-year-old voracious reader, has racked up 94,000 miles on United Airlines in less than a year flying to meet executives at the largest retailers.

He’s making use of a large list of contacts built up from a previous mammoth sales drive that he mounted when working in the grocery business.

Kingsborough founded Blackhawk Network in 2001 and built it into the largest provider of prepaid gift cards by persuading top brands including Starbucks, Nordstrom and Home Depot to sign up early.

The pre-paid cards initially appeared in about 30 grocery stores run by Safeway Inc, a major investor in Blackhawk. In time, Kingsborough got Blackhawk into most other grocery stores across the United States.

Blackhawk is now a unit of Safeway and a significant contributor to the grocery company’s bottom line, according to Bill Bishop of retail consulting firm Willard Bishop.

“Kingsborough demonstrated that it was possible for a grocery supermarket chain to be in other businesses,” Bishop said. “On that lesson, it is safe to give Blackhawk an 11 on a scale of 10.”

PRICE COMPETITION

Kingsborough said his PayPal challenge is similar to the one he faced at Blackhawk.

“Getting consumers to adopt any new thing and having retailers adopt at the same time is difficult,” he said.

One tactic Kingsborough is using is to address retailers’ concern about how much they spend on fees by accepting payments through the established networks run by Visa Inc, MasterCard Inc, American Express Co and others.

Such fees average about 1.5 percent and go higher for transactions over the phone or online, according to Stalder and others. The National Retail Federation estimates such fees cost the industry at least $40 billion a year.

EBay said in its recent annual report that pricing for PayPal’s POS service will be “comparable” to fees merchants pay to competing processors for offline transactions.

Kingsborough went further than that during an interview with Reuters, saying PayPal will subsidize its POS service on an introductory and long-term basis.

“The existing competition has adversarial relationships with retailers. We have love fests,” Kingsborough said. “EBay’s structure gives us a lot more flexibility than if we were starting out as a POS stand-alone business. That enables us to invest in the POS business.”

Initially, this may persuade retailers to test the service, according to Bishop.

“His big opportunity is to help merchants kick the banks off their legs in terms of payment fees for debit and credit. If he can do that, retailers will flock to him,” said Bishop.

Mallory Duncan, general counsel at the National Retail Foundation, said there is demand for alternatives and noted that a number of retailers are exploring these options.

“The unique nature of PayPal’s structure gives them the potential to provide a very price-competitive alternative to the established card brands,” he added. “If they can make a go of that there would be a lot of interest on the part of the retail community.”

FUNDING

PayPal can afford to compete on price because of the way it funds customer payments, according to Gil Luria, an analyst at Wedbush Securities.

Just over half of PayPal transactions are currently funded through debit and credit cards on existing payment networks such as Visa and MasterCard, he estimated.

PayPal has to pay the networks for this. If it charges 1.5% or less for in-store payments that are funded this way, the company will likely lose money on every transaction, Stalder said.

But about 45% of PayPal transactions are funded through users’ bank accounts, or an existing PayPal balance, Luria noted.

“If any of those sources are used, PayPal margins approach 100%,” Luria said.

That’s the key that will allow PayPal to price its POS service aggressively and still make a profit, Luria and Stalder said.

The dominant payment networks “are worried about it,” Luria said. “PayPal is still a drop in the bucket for them, but it’s a long-term concern.”

In a Reuters interview late last year, Amex Vice Chairman Ed Gilligan told Reuters that PayPal has done very well but that it has yet to prove itself in the physical world.

“That’s one of the big gaps that PayPal has — they’re not relevant offline,” Gilligan said.

For PayPal to establish a permanent presence in physical stores, it will have to encourage consumers to use the service, instead of just whipping out their credit or debit cards.

TEST

During a recent test at a Home Depot store south of San Francisco, PayPal appeared as an option at checkout, along with existing payment methods such as Visa and MasterCard.

PayPal works this way: Once items have been scanned, the POS card swiping terminal shows the amount due, plus a new orange buttion saying Pay with PayPal below the usual “Please swipe card” request. A shopper using PayPal selects the PayPal option, confirms the total, enters a cellphone number and finally a four-digit PIN that has been set up beforehand.

Shoppers using debit or credit cards select Swipe Your Card, swipe their credit or debit card and complete their transactions as usual.

The PayPal transaction was processed quickly and a receipt printed out showing the purchase price and PayPal as the source of payment. A few seconds later a confirmation email arrived on the shopper’s mobile phone noting that an electronic receipt had been stored in the user’s PayPal account online.

Despite this seamless transaction, some analysts and investors are concerned that PayPal needs something else to get consumers to switch from plastic. Indeed, for people who still like to swipe, PayPal will send them a card.

DATA, OFFERS

Kingsborough said PayPal’s data is the answer to this challenge.

PayPal plans to share more data with retailers than the current payment networks provide. That extra information will help stores send more relevant and timely offers to shoppers, encouraging them to use the service more, Kingsborough said.

The existing payment networks usually share little information with retailers, beyond the last four digits of a credit or debit card. That is because they are trying to prevent people’s names and card details getting into the wrong hands, Luria explained.

PayPal only uses an email address and password for online transactions, and it will use a mobile phone number and PIN for offline transactions. Because card details are not involved, PayPal is more free to share other information it collects, Luria said.

PayPal already knows users’ names and their purchases online. For the offline service, PayPal plans to combine that base of information with other data it and eBay have amassed on shopping habits, consumer locations and product preferences and recent product searches.

Sharing such information with retailers will help them send coupons and other offers and discounts to users’ smart phones as they enter a store, rather than the current situation in which a coupon is spat out as people checkout, Kingsborough said.